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A Free Market Winner Vs. A Soviet Style Loser

August 02, 1998

Economic Viewpoint

A FREE-MARKET WINNER VS. A SOVIET-STYLE LOSER

I recently visited several small ex-Soviet republics, including Georgia and Uzbekistan, that have followed very different policies after becoming independent of Russia. The sharp contrast in their performance vividly demonstrates the economic advantages of speedy transitions to market economies. However, the comparison also explains why many ex-communist nations have found it difficult politically to move quickly.

The Republic of Georgia, a nation of only 5 million people situated in the beautiful Caucasus mountains, went through a bloody civil war against Russian-supported groups between 1990 and 1992. Since 1994, President Eduard A. Shevardnadze of perestroika fame has led the nation rapidly toward fundamental changes. In that year, Georgia created a new currency after a nasty bout of hyperinflation, and annual price increases have been in single digits for the past couple of years.LOOKING FOR CASH. All government-owned small- and medium-size businesses, and many large ones, have been privatized, and wages and most prices have been freed. The private sector now accounts for about three-quarters of total output. Young, energetic entrepreneurs are starting small businesses at a fast rate and are looking for foreign investors for capital. Although gross domestic product fell drastically during the civil war, it has been growing from 7% to 11% during each of the past three years.

The International Monetary Fund supplied desperately needed financial assistance during the first few years, but some of its advice has become an obstacle to further progress. The IMF has been pressing the government to raise taxes although rates are already too high for a poor nation that desperately needs to encourage investment and hard work. The VAT and profit tax rates equal 20%. To avoid such a heavy burden, almost half the economy has moved underground, so that tax revenues are less than 10% of output. I believe that either Georgia's VAT or income tax alone would be more than sufficient, and all other taxes should be abolished. The result would be greater investment, faster growth, a decline in the black economy, and perhaps even larger revenue from taxation.

However, Georgia apparently can only introduce such tax cuts by ending its dependence on the IMF. To ensure that the rate of growth does not slow, the U.S. should consider replacing the IMF funds. A prosperous Georgia would show all the countries in the Caucasus and Central Asian regions that market-oriented domestic policies, and not dependence on Russia, are the path to economic success.

Unfortunately, Uzbekistan's policies are mainly the opposite of Georgia's. While it pays lip service to a good World Bank plan for extensive privatizations, Uzbekistan has only privatized a small part of the economy. Economic activities are still tightly controlled by various government monopolies that have depressed production. As a result, aggregate output is stagnating and perhaps even falling, even though it is already at a distressingly low level. Uzbekistan is still pursuing the old Soviet-style approach through a powerful authoritarian President, limited freedom of expression, and a stubborn reluctance to give up centralized direction of the economy. Despite outstanding historical sites that could attract tourism to Samarkand and other cities along the old silk route from China, Uzbekistan has an unpromising future.DESPERATION. The contrast between Georgia and Uzbekistan shows that the best way to generate growth is through speedy transition toward a decentralized economy. Yet reform also has a short-run price that explains the reluctance of most ex-Soviet republics to change quickly. Free markets provide enormous opportunities for the young and energetic, but they often hurt politically influential groups who benefited from the old system: pensioners, employees at inefficient state enterprises, and government officials. Even President Shevardnadze replied to my compliment on the rapidity of reforms in Georgia by saying they had no choice, since they were desperate.

Experience shows that political opposition to needed reforms becomes stronger, not weaker, the more they are delayed. In the long run, the economies of Georgia, Poland, and others that have reformed quickly will far outstrip the laggards because their higher growth rates will have an enormous cumulative effect. The elderly as well as the young will eventually be much better off in countries that change rapidly than in Uzbekistan, Azerbaijan, Romania, and other nations of Central Asia and Eastern Europe that cling to command-and-control economies for short-run political advantages.BY GARY S. BECKER